In between news about George Clooney’s wife and property prices, the media has found plenty of space to write about the ‘oil price war’. Fairfax and News press have both got into the action, portraying the dramatic slump in oil prices as collateral damage from a conflict between the Saudi’s and North American shale producers.
The narrative goes like this: oil prices have fallen because OPEC, led by Saudi Arabia, refuse to cut production in response to slower demand. They refuse to cut production because they are concerned about the explosion of supply from shale producers in America and now want to engineer oil prices low enough to force shale producers out of the market. This ‘war’ will only end when the Saudi’s are satisfied that shale producers have been hurt enough; only then will they allow the price of oil to rise.
That is rubbish.
Saudi Arabia is the world’s lowest cost oil producer, able to extract oil at US$5-6 a barrel. The cost of extracting oil from shales ranges from U$35-$100 with an average cost of about US$70 a barrel.
Let’s assume Saudi Arabia (or any other low cost producer) cut 1m barrels of output. That move would have no impact on prices because high cost producers would quickly replace the lost 1m barrels of production. By cutting output, the Saudis would be gifting additional revenue to higher cost producers. The Saudi’s aren’t at war with anyone. They are acting rationally, just like any other low cost producer in a commodity market would.
Just look at BHP and Rio who are furiously expanding iron ore supply despite falling prices. They are doing so because it makes no sense for the lowest cost producer to exit first. Shale producers will be hurt from the actions of OPEC but so will all high cost oil production. This is no war; it is economics playing out as it should.